Business context and reporting period
Applied Industrial Technologies, Inc. distributes industrial and fluid power products and provides related engineering and service offerings across North America, Australia and New Zealand. This Form 10-Q covers the three months ended September 30, 2015, the first quarter of fiscal 2016; comparisons are with the three months ended September 30, 2014. Unless otherwise stated, amounts are in millions.
Financial performance and position
| Metric | Quarter ended Sep. 30, 2015 | Prior-year quarter |
|---|---|---|
| Net sales | $641.9 | $702.3 |
| Gross profit / margin | $181.0 / 28.2% | $194.9 / 27.8% |
| Operating income / margin | $41.0 / 6.4% | $46.2 / 6.6% |
| Net income | $24.3 | $29.1 |
| Diluted EPS | $0.61 | $0.70 |
| Operating cash flow | $14.6 provided | $18.1 used |
Sales fell 8.6%; net income declined 16.6%. Gross margin improved 0.4 percentage points, while SD&A increased to 21.8% of sales from 21.2%. Interest expense rose to $2.2 from $1.7, and other expense was $1.0 versus $0.2. The effective tax rate was 35.8% versus 34.2%.
At September 30, cash was $64.0, current assets $813.9, and current liabilities $258.3; working capital was $555.6 and the current ratio was 3.2:1. Total borrowings were approximately $355.3, up from $321.0 at June 30; net of cash, debt was approximately $291.3. The $150.0 revolving facility had $87.0 drawn and $59.2 available after letters of credit. Shareholders’ equity was $710.1, down from $741.3 at June 30.
Cash declined $5.5 to $64.0. Investing used $14.2, including $11.3 for business acquisitions and $3.1 for property purchases. Financing used $2.3, including $18.0 for treasury-share purchases and $10.7 for dividends, partly offset by $35.0 of revolving-credit borrowings. Foreign exchange reduced cash by $3.5. Other comprehensive loss was $27.5, primarily from foreign-currency translation.
Material changes versus the prior comparable period
- Management attributed the $60.4 sales decline to $22.8 of unfavorable currency translation, partly offset by $12.9 from acquisitions. Excluding acquisitions and currency, sales fell 7.2%.
- Upstream oil and gas-focused businesses accounted for 4.9 percentage points of the 7.2% organic/currency-adjusted decline; traditional core operations accounted for 2.3 points. Service Center Based Distribution sales fell 8.1%, and Fluid Power Businesses sales fell 10.9%.
- Segment operating margins declined: Service Center Based Distribution to 5.7% from 6.5%, and Fluid Power Businesses to 9.1% from 10.2%, as lower sales and gross profit were not matched by equivalent expense reductions.
- Operating cash flow improved from use of $18.1 to generation of $14.6, mainly reflecting lower working-capital needs amid reduced sales.
- Basic weighted-average shares fell to 39.6 million from 41.5 million, supporting EPS; the quarterly dividend per share increased to $0.27 from $0.25.
Outlook, risks and unusual items
Management expected the full-year fiscal 2016 tax rate to be 34.5%–35.0% and expected operating cash flow to improve through the year. It expected inventory turnover for the fiscal year to be similar to or slightly better than the 3.6 rate at quarter-end. The filing provides no specific sales or earnings guidance.
Management cited weaker industrial economic indicators and continuing weakness in energy markets. The doubtful-account provision rose to $1.7 from $0.4, and to 0.27% of sales from 0.06%; the company attributed the increase primarily to oil and gas customer exposure. It recorded $0.5 of severance expense and $1.4 to increase oil-and-gas-related receivables allowances. Management warned that prolonged low oil and gas prices could trigger goodwill or intangible-asset impairment, particularly given acquired energy-sector businesses. Currency movements, customer demand and collections, acquisition integration, and debt and capital access are also risks.
On August 3, 2015, Applied acquired Atlantic Fasteners for $12.5, funded at closing with revolver borrowings. After quarter-end, on October 1, it acquired S.G. Morris for $14.5, also funded with revolver borrowings. Management reported effective disclosure controls; it also noted that the ongoing SAP implementation and new consolidation process pose risks to maintaining internal controls. The independent accountant performed an interim review, not an audit, and reported no material modifications needed to the interim statements.
Important facts for investors to verify
- Whether sales and margins stabilize, particularly in oil and gas markets, Canada and Fluid Power operations.
- Whether the increase in doubtful-account reserves adequately reflects customer credit risk and collections.
- Debt levels, borrowing costs, and remaining revolver and shelf-facility capacity after acquisitions and any further repurchases.
- Whether low energy prices, foreign exchange or revised forecasts lead to goodwill or intangible-asset impairment.
- Progress and control implications of SAP implementation, and integration and performance of recent acquisitions.
- Whether management’s expected improvement in fiscal-year operating cash flow and stated tax-rate range are achieved.